Nasdaq 8%, Russell 10% And S&P 500 4% Correction, What’s Next?

The question investors have on their minds, after an 8% Nasdaq (COMPQ) correction, 10% Russell 2000 (RUT) correction, and recent 4% pullback in the S&P 500 (SPX)... then watching all major indices rally in the final 2 days of trading this past week is... "What comes next?"

Below is the updated chart on the S&P 500, 2009/2010 analogue relative to the 2020/2021 period. The current S&P 500 drawdown as of last week's close was -1.68% starting from a peak on May 7th. 

I expected the pullback to be in the -5% to -8% range; through Wednesday (5/12) it had been only -4.0 percent. While there has been a strong 2-day bounce, it is still a little too early to declare the pull back over. Either way, seasonality is probably playing a bigger impact on markets than the actual fear of rising inflation. Now let's take a look at a couple of charts that inform of Dow Theory:

As we can see in the above charts, both the Dow Jones Industrial Average and the Dow Jones Transports have achieved their respective 261.8% Fibonacci expansion levels. With the upside objectives achieved in arguably the 2 most important stock market indexes, the question becomes whether or not now is the time to press new aggressive longs? Finom Group has been long through our MasterMind Options trade alert in Dow Industrial Average ETF (DIA) and issued a trade alert this past week to take some profits on this trade idea.

Having said that, here is a chart of leadership with respect to DIA vs. DJT. Dow Jones Transports continues to outperform the Dow Jones Industrial Average itself. This is likely a byproduct of the pandemic and post-pandemic period that has become that much more reliant on spending on goods more so than services. Goods demand more shipping and transporting of course.

Given the aforementioned, Transports may hold up well relative to the Dow itself. Here is some historical data via Schaeffer on Dow Theory when Transports are outperforming Industrials as they are this year.

Even though we could experience some volatility near-term, this looks bullish longer-term, and with Dow Jones Transports outperforming the Dow going forward. The Golden Capital Portfolio is long the Dow and owns several stocks that reside in the Dow, including Wal-Mart (WMT), Apple (AAPL), Caterpillar (CAT), and Boeing (BA). Now let's get into some Technology and the growth part of the markets via the Nasdaq and its likeness.

Two areas of financial markets that don’t like inflation are U.S. Treasuries and growth stocks, and in the first 3 days of this week, the Nasdaq was down 5% while long-term U.S. Treasuries were down over 2 percent.  It’s not often that you see declines this large at the same time. What happens next? The average 12-month return after 8 occurrences for NDX/TNX... 31.8 percent. If we Ex-2000 the returns jump to  38.9 percent.

There continues to be a strong performance attached to the reopening/cyclical parts of the market that are less impacted by rising rates and/or inflation. It's one of the reasons the Dow and even the small-cap Russell 2000 (IWM) have performed so well over the last 7 months. The Russell is still undergoing a consolidation period that may soon find its way to the Dow, but until it does it is just speculation, based on the weight of the evidence.

The small-cap ETF (IWM) identifies a clear line of support going back to January 2021. This past week that support was successfully tested once again, and where the bulls defended well. The next test will be to see when the IWM rises back above the 50-DMA, somewhat akin to the next achievement the Nasdaq will need to accomplish. It's rare to see this level of small-cap outperformance compared to the Nasdaq.

While we can't rule out upside or downside in the near term for the small caps, one strategist is of the opinion that the next 10 days will result in a massive move for the IWM, Fundstrat's Tome Lee.

"STRATEGY: Tradeable low in place, with multiple factors explaining why IWM could rally ~10% over the next two weeks.

We think IWM is set for a possible surge higher over the next 10 days. This is a high-risk and tactical call. So we are not saying "bet the farm" but it is a "back up the truck moment"

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